Australian GST would be much easier if everything had 10% GST. Sell something for $100. Add $10 GST. Collect $110. Job done.

Unfortunately, the GST law had other plans. Some sales are taxable. Some are GST-free. And some are input-taxed.

The last two are particularly good at confusing beginners. After all, GST-free and input-taxed sales both have something rather attractive in common: You don’t charge GST.

So why give them different names? Because what happens to the GST on your expenses is very different. That difference is the key to understanding all three. So, get your diary ready. We are going to sort them out.

First, the three types in one table

Before we go any further, have a look at this:

Type of sale	Charge GST?	Claim GST credits on related purchases?
Taxable	Yes	Generally, yes
GST-free	No	Generally, yes
Input-taxed	No	Generally, no

That little table explains most of this article.

The ATO makes the same basic distinction. GST is collected on taxable sales, while GST-free and input-taxed sales do not have GST added. The important difference is that GST credits can generally be claimed for purchases used to make GST-free sales but generally cannot be claimed for purchases used to make input-taxed sales.

Now let us make some sense of it.

1. Taxable Sales

This is the ordinary GST situation. If your business is registered for GST and makes a taxable sale, you generally include GST in the price.

Suppose you are an accountant. You charge a client:

Accounting fee: $1,000
GST: $100
Total invoice: $1,100

The client pays you $1,100.

The $100 is GST collected on the sale. You report the GST through your BAS. Simple enough.

The ATO says that, broadly, sales made for payment in the course of operating your business and connected with Australia are taxable where the relevant requirements are met, unless the sale is GST-free or input-taxed.

But there is another side to the story

You probably had expenses while earning that income. Perhaps you bought office supplies.

Suppose they cost:

Office supplies: $330 including GST.

That contains:

Cost: $300
GST: $30

If the normal GST credit requirements are satisfied, you can generally claim the $30 GST credit.

So you have:

GST collected: $100
GST credit: $30
Net GST: $70

This is the normal GST cycle. You collect GST. You claim eligible GST credits. You pay the difference.

2. GST-Free Sales

The name gives us a fairly good clue. A GST-free sale does not have GST added to the price. Suppose something is sold for $100 and the sale is GST-free.

The customer pays: $100

Not $110.

There is no $10 GST to collect.

Certain basic foods are common examples. The ATO lists items such as fruit and vegetables, meat, bread and plain milk among GST-free basic foods. Certain health services, education services and exports can also be GST-free when the relevant requirements are satisfied.

But GST-free does not mean GST is irrelevant to the business. This is where things become interesting.

You can generally still claim GST credits

Imagine you run a business making GST-free sales. You sell $10,000 worth of qualifying GST-free products. You charge:

Sales: $10,000
GST: $0

Now suppose you purchase eligible business supplies for:

$1,100 including $100 GST.

You did not collect GST from your customers. But you may still be able to claim the $100 GST credit on your business purchase. The ATO confirms that GST credits can generally be claimed for GST included in purchases used to make GST-free sales.

This gives us an important rule:

GST-free = no GST on the sale, but GST credits are generally available on related eligible purchases.

Remember that. Because it is precisely where input-taxed sales are different.

3. Input-Taxed Sales

Now we come to the slightly awkward member of the GST family. An input-taxed sale also generally has no GST charged to the customer. So far, it sounds exactly like GST-free.

But there is a catch. You generally cannot claim GST credits for purchases relating to input-taxed sales. And that changes everything.

Residential rent is an easy example

Suppose you own a residential property and rent it to a tenant for use as their home.

Assume the rent is: $2,000 per month.

You do not simply add 10% GST and ask the tenant for $2,200.

Leasing residential property is generally an input-taxed supply.

So:

Rent: $2,000
GST: $0
Tenant pays: $2,000

Now suppose you incur an expense directly relating to that input-taxed rental activity. A contractor charges you: $1,100 including $100 GST. Here is the important part. Because the expense relates to making an input-taxed supply, you generally cannot claim that $100 as a GST credit. The GST becomes part of your cost. And that is the big difference.

GST-Free vs Input-Taxed

This is where most beginners get stuck. So forget the technical language for a moment. Think about it from the business owner’s side.

GST-Free

You tell your customer: “I don’t charge you GST.” Then, subject to the normal rules, you can tell the ATO: “But I would still like the GST credit on my eligible business purchases.”

Input-Taxed

You tell your customer: “I don’t charge you GST.” Then the GST system generally tells you: “Fine. But you don’t get GST credits on purchases relating to that input-taxed sale either.”

That is the distinction. Once you understand that, the names become much less intimidating.

Let us compare all three

Suppose three businesses each make sales of $10,000. Each also incurs $1,100 of eligible expenses, including $100 GST, directly relating to those sales. For simplicity, assume all the normal GST requirements are satisfied.

Business A – Taxable Sale

It charges GST.

Sale: $10,000
GST: $1,000
Customer pays: $11,000

It has $100 GST on eligible purchases. It can generally claim that $100. So:

GST collected: $1,000
GST credit: $100
Net GST: $900

Business B – GST-Free Sale

It does not charge GST.

Sale: $10,000
GST: $0
Customer pays: $10,000

But it has $100 GST on eligible purchases used to make those GST-free sales. That GST can generally be claimed. So:

GST collected: $0
GST credit: $100

The GST position may therefore contribute to a refund, depending on the rest of the BAS.

Business C – Input-Taxed Sale

It also does not charge GST.

Sale: $10,000
GST: $0
Customer pays: $10,000

It has $100 GST on purchases relating to the input-taxed sale. But that $100 generally cannot be claimed as a GST credit. So:

GST collected: $0
GST credit: $0

The $100 GST effectively remains part of the business’s cost. Now the difference should be much clearer.

A very simple way to remember it

When looking at a transaction, ask two questions.

Question 1: Do I charge GST?

If yes, you are probably looking at a taxable sale. If no, keep going.

Question 2: Can I claim GST credits on related purchases?

If generally yes: GST-free. If generally no: Input-taxed.

Of course, actual GST law contains exceptions, special rules and apportionment requirements. Tax law would become terribly lonely without exceptions. But this two-question approach is an excellent starting point.

Common examples of taxable sales

Most ordinary goods and services supplied by a GST-registered business will be taxable unless a GST-free or input-taxed rule applies.

Common examples may include:

• professional services
• accounting and bookkeeping services
• clothing
• electronics
• restaurant meals
• many trades and repair services
• commercial rent

Do not decide the GST treatment merely from what an item is called. The circumstances of the supply matter. A particularly good example is food.

Food can become surprisingly complicated

Walk into a supermarket and GST can become an interesting little puzzle. Bread may be GST-free. Plain milk may be GST-free. Fruit and vegetables may be GST-free. But that does not mean all food is GST-free.

How the food is prepared, sold and classified can change the GST treatment. Two products sitting next to each other on a supermarket shelf can have different GST treatment. So never adopt the rule: “It is food, therefore there is no GST.” That rule will eventually betray you.

GST-free health services

Certain health services can be GST-free when the requirements in the GST law are satisfied. The important word is certain. It does not mean every product or service connected with health automatically becomes GST-free. A business needs to consider the particular service and whether the legal conditions are met.

The same principle applies to education. Certain education supplies can be GST-free. That does not mean everything described as a “course” automatically escapes GST. Labels are easy. GST classification is about the actual supply.

What about exports?

Some exports can also be GST-free when the relevant conditions are satisfied. This creates an interesting result. An Australian business might make a sale to an overseas customer and charge no Australian GST because the supply qualifies as GST-free.

Yet the business may still be entitled to GST credits on eligible Australian purchases connected with making that GST-free supply. Again:

No GST on the sale. But potentially: GST credits on eligible purchases. That is the GST-free model.

Common examples of input-taxed sales

The ATO gives common examples including:

• leasing residential property
• sales of existing residential property in relevant circumstances
• certain financial transactions, such as providing a loan.

Financial supplies can become quite technical. So can property. For a beginner, the important lesson is simply this: Input-taxed does not mean GST-free. Do not use the terms interchangeably.

Residential rent vs commercial rent

This is a useful comparison. Suppose you own two properties. One is a house rented to a family. The other is a shop rented to a business. They may look similar from an accounting perspective. Every month, rent comes into your bank account. But their GST treatment can be very different.

Residential rent is generally input-taxed. Commercial rent, where the relevant GST requirements are satisfied, will generally be taxable. So the GST treatment does not depend simply on the fact that you received “rent”. You need to know what kind of rent.

This is why good bookkeeping needs more than a ledger called: Rent Income. Sometimes the accountant needs to know the story behind the number.

Why does the distinction matter so much?

Because choosing the wrong GST code affects both sides of the transaction. If you incorrectly treat a taxable sale as GST-free, you may fail to account for GST that should have been paid. If you treat a GST-free sale as taxable, you may incorrectly charge your customer GST. And if you treat an input-taxed activity like a GST-free activity, you might claim GST credits you were not entitled to claim.

One innocent-looking tax code in your accounting software can therefore travel all the way into your BAS. The software will happily calculate whatever you tell it to calculate. It has no idea whether you were right.

What if a business makes different types of sales?

Very common. A business does not have to live entirely in one GST category. It might make: taxable sales and GST-free sales and perhaps even input-taxed sales.

Now the bookkeeping becomes more important. You need to identify which purchases relate to which activities. Some expenses may relate entirely to taxable sales. Some may relate entirely to input-taxed sales. Others may be shared.

Shared expenses can require an appropriate GST credit apportionment. This is one of those points where the simple GST lesson ends and proper GST accounting begins.

Do not confuse “no GST” with GST-free

This deserves its own section. Suppose you see an invoice with no GST. That does not automatically mean the transaction is GST-free. There can be several reasons why GST does not appear. The supply might be GST-free. It might be input-taxed. The supplier might not be registered for GST. The transaction might be outside the GST system for another reason. So when bookkeeping, avoid thinking:

No GST = GST-free.

That shortcut can cause trouble. Instead ask: Why is there no GST? That is the better question.

A bookkeeper’s quick test

When you enter a transaction, stop for a few seconds. Ask yourself:

What exactly was supplied?

Then:

Is it taxable, GST-free or input-taxed?

Then:

Was GST actually charged?

And finally:

Are we entitled to claim the GST credit?

Those few seconds can save a rather unpleasant afternoon when the BAS is being prepared.

The one table worth remembering

If the terminology disappears from your head tomorrow morning, come back to this:

	Taxable	GST-Free	Input-Taxed
GST charged on sale?	Yes	No	No
GST credits generally available on related eligible purchases?	Yes	Yes	No
Common example	Professional service	Basic food	Residential rent

The ATO’s guidance follows this same fundamental distinction. If you remember the middle and last columns, you have understood the hardest part.

One final example

You buy a loaf of qualifying GST-free bread. There is no GST. You rent your home. There is generally no GST. At first glance, the two transactions seem to receive the same treatment. But they arrive at “no GST” by two different roads.

The bread can be GST-free. Residential rent is generally input-taxed. For the customer, the difference may not seem terribly exciting. For the business claiming GST credits on its expenses, it matters enormously. And that is really the whole story.

Taxable: GST on sales. GST credits generally available.

GST-free: No GST on sales. GST credits generally available.

Input-taxed: No GST on sales. GST credits generally unavailable for related purchases.

Three categories. Two questions. And considerably less mystery than their names suggest.